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One of the most important decisions a trader must make when entering a position is determining when to sell or close out the trade. It is imperative to set a target exit point for each trade. A target exit point is an option price that would result in a substantial, yet attainable, profit.

By setting your profit objectives in advance and determining your target exit point before you trade or at the time you make your option purchase, you avoid the consequences of one of the major stumbling blocks to achieving trading profits, which is greed. It is very hard for most investors to set reasonable profit goals once an options has jumped substantially in price. That extra point becomes a moving target with each advance in the option’s price. Therefore, it is not surprising that a reasonable profit is not achieved when the investor is forced to bail out because of tumbling prices.

Although setting profit goals in advance may be simplistic and not the most flexible approach to option trading, the target exit point approach to taking profits is a necessary compromise especially for the options trader who has neither the savvy nor the emotional control to know when to hold and when to fold in the heat of battle, and who is also unable to stay tuned to the markets throughout the trading day.

Note also that the profit objective should be substantial, meaning at least 100 percent, or double your initial investment, so you will not be walking away with small profits by using this approach. With this approach, you will miss out on those 1,000 percent gains that are the options equivalent of hitting the jackpot, but much more important, you will minimize the instances of solid profits becoming painful losses and you will regularly be taking respectable gains off the table.

Once you have entered the heat of battle, the tendency will be to base your decisions upon emotion, and therefore your decisions will tend to be incorrect. To avoid this pitfall, set a closeout date based on the amount of time you expect the option needs to reach its target exit point. If that profit level has not been reached by the closeout date, exit the position on that date. Closeout dates should be set so that there is still enough time until expiration to salvage some time value from the option if the underlying stock has failed to move.

Resist the temptation to sell at a small loss prior to your closeout date. You will be yielding to fear, robbing yourself of some potential gains. Also, resist the temptation to raise your profit objective as the price of the option nears your target exit point. You will then be yielding to greed, and your profits will slip away.

Another important question that needs to be addressed is when should you not sell? You should not sell a position the instant it moves against you. There is never a need to engage in panic selling if it is assumed that your original conditions for opening the position still hold true. For example, your market outlook and your outlook for the stock on which you own options has not changed; also, that you are not committing an excess amount of trading capital and you are still operating within your own risk tolerance.

As option traders we create option positions for their huge profit potential, which can be fully realized only by allowing positions to remain open for a reasonable period of time. Setting predefined exit points goes a long way in facilitating this task.

Happy Trading.


Jeff Neal
Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
jeff@optionetics.com

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